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May 13, 2006

Companies headed by founders perform better

Research by Fortune magazine, found that the stocks of 26 Fortune 500 companies, where a founder still remains CEO - including Apple Computer, FedEx and Cardinal Health - "returned an average of 18.5 percent annually from year-end 1995 through 2005, which is 7% better than the Fortune 500's average return over the same period. Their profit growth has been superior, too, increasing at an average rate of 19.6 percent a year from 1995 to 2005, vs. 11.7 percent for the Fortune 500". (The Fortune list does not include Dell, Nike, Microsoft, and Starbucks, whose famous founders are now chairmen.)

Fortune's findings were backed up by the research of an Ohio State University professor, Rudiger Fahlenbrach, who found that such companies beat the broader market by eight percentage points from 1993 to 2002.
Fahlenbrach has a few theories on why founder-CEOs seem to be better corporate stewards. One is that they simply care more. Their companies are their life's work, so they're more likely to embrace long-term strategies. Supporting the theory is Fahlenbrach's finding that founder-run companies have bigger capital budgets and invest considerably more in research and development than nonfounder-run firms.

Fahlenbrach's thesis resonates with founder-CEOs we talked to. "I'm emotionally attached to this company, which means I'm going to do whatever it takes to protect its financial integrity," says Angelo Mozilo, who co-founded mortgage company Countrywide Financial in 1969. "There's no way a babysitter can feel the same way about a child as the parents."

Founders = Parents. Professional CEOs = Baby-sitters.

An interesting - data-backed - analogy indeed.
Fahlenbrach's other big theory on the founder premium: They tend to be industry experts, not managerial mercenaries. Sinegal started out in the supermarkets as a bagger, Kinder has 20 years in the energy biz, and L-3's Frank Lanza is an engineer by training who rose through the corporate ranks of Loral and Lockheed Martin before co-founding L-3 in 1997.

CEOs with resumes like these "tend to stick with what they know," says Fahlenbrach. That means they're less likely to make the kind of disastrous "diversifying" acquisitions that give M&A a bad name. L-3's Lanza says investment bankers are constantly pitching him proposed acquisitions that would move L-3 beyond the defense sector. "But we don't have the marketing or distribution know-how to do that," he says. "We've made a point to stick to our knitting." With L-3's stock up 110 percent since 2001, Lanza's shareholders are no doubt glad he does.

Arun Natarajan is the Founder of Venture Intelligence India, which tracks venture capital activity in India and Indian-founded companies worldwide. View sample issues of Venture Intelligence India newsletters and reports.